January 26, 2016 / 11:49 AM / 2 years ago

UPDATE 3-Fitch revises NZ outlook down to stable, maintains sovereign 'AA' rating

(Recasts; adds background about dairy, comment from ASB economist)

WELLINGTON, Jan 27 (Reuters) - Credit ratings agency Fitch Ratings on Tuesday revised downward its outlook on New Zealand's government bonds to stable from positive, citing weakness in its cornerstone dairy industry, a further sign that the country's status as a "rock-star economy" was over.

The ratings agency left the sovereign rating unchanged at 'AA', but also revised downward the outlook for the country's banking sector to negative from stable on the likelihood low dairy prices would make it harder for farmers to service debts.

The New Zealand dollar edged slightly lower after the announcement to $0.6435, but recovered to $0.6504 in early trading on Wednesday.

Dairy prices have been falling from record highs in 2013 as demand from China slows amid a global oversupply. New Zealand's Reserve Bank has repeatedly flagged the sector, which represents around a quarter of the country's exports, as a key risk to financial stability.

Unlike other major dairy producers, such as the United States, nearly all of New Zealand's supply is exported, making it particularly vulnerable to any price swings.

Softer growth and weak inflation prompted the RBNZ to cut its benchmark interest rate in December to match a record low of 2.50 percent.

The bank is widely expected to leave rates unchanged this week, although pressure for cuts is building, in particular as the economy teeters on the verge of deflation.

"The Fitch revision by itself doesn't change the case for cuts," said ASB Rural Economist Nathan Penny. "However, low dairy prices and associated weak dairy sector incomes are part of the overall case for OCR cuts this year." Penny expects the central bank to cut the cash rate in June and August this year.

Mark Johnson a private client manager at OM Financial Ltd, said an RBNZ cut this week would be a shock, but it was possible that the central bank would warn of the risks ahead.

Growth in New Zealand's gross domestic product slowed to 2.3 percent in 2015, according to Fitch estimations, meaning the country was no longer out-performing its AA-rated peers.

Fitch said it expected GDP growth to pick up to 2.4 percent in 2016 and to 2.6 percent in 2017, a slower pace than it had forecast in its July 2015 review.

Fitch said it expected a slight recovery in business investment from its current, subdued level, and continued high net immigration levels to support consumption growth.

However, that will probably be offset by lower dairy production and slower residential investment growth, the agency said. Uncertainty over migration rates and the impact of El Niño weather were also risks to its forecast, Fitch said.

The banking sector outlook was revised because a second season of low dairy prices is likely to make it harder for farmers to service their debt. About half the dairy sector is estimated to be facing negative cash flow during the 2014-15 season, Fitch said. (Reporting by Charlotte Greenfield and Jane Wardell; editing by Larry King and G Crosse)

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